Global X took a unique approach to celebrating a holiday dedicated to the Mexican Army’s defeat of French troops at Puebla: The issuer unveiled the first U.S.-listed ETF offering exposure to small-cap Mexican stocks. The Global X Mexico Small-Cap ETF (MEXS) will seek to replicate the Solactive Mexico Small-Cap Index, a benchmark that consists of about 28 small-cap companies that are domiciled in Mexico or maintain their primary business operations in Mexico.

MEXS is the second pure play Mexico ETF, hitting the market more than 15 years after iShares debuted its MSCI Mexico Index Fund (NYSEARCA:EWW). That fund, which has close to $1.7 billion in assets, is comprised primarily of giant and large-cap stocks, and small caps make up less than 10% of holdings. ProShares also offers 200% leveraged (NYSEARCA:UMX) and -200% leveraged ETFs (NYSEARCA:SMK) designed to amplify daily exposure to the MSCI Mexico Index.

Recent innovation in the ETF space has included a wave of small-cap international equity ETFs, many of which investors have embraced as a better way to achieve “pure play” exposure to local economies. According to the ETF screener, targeted exposure to small cap stocks is now available for a handful of emerging and developed markets, including Australia, Japan, South Korea, Taiwan, Germany, China, India, Russia, Brazil and Canada.

Small-Cap Difference

The ETF universe has expanded in recent years to offer targeted exposure to nearly every corner of the globe. Investors seeking access to Vietnam can find it through VNM, while those looking to bet on Poland (NYSEARCA:PLND) (NYSEARCA:EPOL) or Indonesia (NYSEARCA:IDX) (NYSEARCA:EIDO) have multiple funds to choose from. Even tiny Ireland (NYSEARCA:EIRL), Philippines (NYSEARCA:EPHE) and Chile (NYSEARCA:ECH) have dedicated ETF options.

But the majority of existing international ETFs were built to offer exposure to the largest publicly-traded companies in that market, meaning that the “first generation” of products is tilted heavily toward large-cap stocks. That can diminish the correlation between performance and the strength of the local economy, as large-cap stocks tend to be multi-national companies that conduct business around the globe and may generate significant portions of earnings outside the country where their headquarters are located. Small-cap companies are more likely to depend on changes in local consumption, and can be seen as “closer to the ground” in the local markets.

“MEXS provides an efficient way to play Mexico’s domestic growth story,” said Bruno del Ama, chief executive officer of Global X Funds. “Improvement in Mexico’s terms of trade with the U.S., its largest trading partner, has helped to increase investment in domestic industries.”

The exposure offered by MEXS will be drastically different from the large cap-heavy EWW. MEXS will afford the largest sector weightings to consumer discretionaries (29%), industrials (23%) and consumer staples (20%), with the remainder spread across financials, materials, healthcare and telecom (which makes up about 2%). Telecom is the largest sector weighting in EWW, making up about 28% of assets.

MEXS will also feature considerably more balance than its large-cap counterpart, which weights close to a quarter of assets to telecom behemoth America Movil (NASDAQ:AMOV). The four largest components of EWW make up close to half of total holdings, while the largest security in MEXS accounts for just over 5% of assets.

Because there is virtually no overlap between the funds, MEXS can be used either as a complement to EWW or perhaps as an alternative for those looking to overweight the Mexican economy. The new ETF can also be potentially used in pairs trades - such as going long MEXS and short EWW (or vice versa).

Case for Mexico

Mexico is home to a unique economy that has experienced huge swings over the last several years. After experiencing the worst contraction since the 1930s in 2008, strong GDP growth returned the following year as exports accelerated. A number of reforms over the past decade have helped to increase competitiveness and grow the role of the private sector. Though most investors seeking emerging markets exposure focus on the BRIC bloc, Mexico is one of the world’s largest developing economies as measured by GDP, while on a per capita basis, Mexico’s economy is larger than China, India and Brazil.

Mexico’s best chance for strong, sustained economic expansion centers around increased free trade agreements. Former president Vicente Fox recently urged the U.S. and Canada to expand NAFTA to further integrate with Mexico, holding up the European Union as a model.

There are, of course, significant risks inherent in an investment in Mexican equities as well. Caught between the U.S. and many major drug exporters, Mexico has seen drug-related violence escalate precipitously in recent years. Brutal killings and increased gang presence are deterring tourism and international investment, stymieing long term growth potential in the process.

Disclosure: No positions at time of writing.

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